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8/14/2019 Ron Laurie
1/21
The Role of Claims Constructionin Patent Valuation
Advanced Topics in IP Valuation and Analysis
Presented by the IP Societyin conjunction withTownsend and Townsend and Crew, LLP & QuantAA
Palo Alto - July 13, 2004
Ron LaurieManaging Director Inflexion Point Strategy, LLC
8/14/2019 Ron Laurie
2/21
Patent Valuation
Valuation Contexts Transaction Based
M&A Price Allocation, Exchange Ratio, Premium
Technology Divestiture Spin Out (Newco) vs. Spin-Off (sale)
Joint Venture or Strategic Alliance In-kind contribution value
Venture Investment Decisions Angels, VCs, Private Equity
Patent Brokerage - Purchase/Sale of IP only (vs. technology)
License Fees - Paid-up, Upfront payments & royalty rates
Collateralization and securitization of IP
Inter-Affiliate Transfers Transfer pricing issues
8/14/2019 Ron Laurie
3/21
Patent Valuation
Valuation Contexts - Non-Deal
Strategic IP Position Enhancement IP Aggregation
Purchase vs. Exclusive License vs. Non-exclusive License
Litigation
Damages - greater of infringers profits or reasonable royalty
Settlement value
R&D Investment Make vs. buy decisions, Determination of IP-ROI
Portfolio Management Foreign filing and prosecution costs, Maintenance fees
Charitable Donations Tax benefit
8/14/2019 Ron Laurie
4/21
8/14/2019 Ron Laurie
5/21
Patent Valuation
SFAS 141/142 - Categories of Identifiable Intangibles
Marketing-related: trademarks, trade dress, domain names, non-competes, etc.
Customer-related: customer lists, contracts and non-contractual relationships
Artistic-related: print publications, video, music, photos, etc.
Contract-based: license agreements, employment contracts, broadcast rights, etc.
Technology-based: patented technology, trade secrets, software, databases, maskworks, unpatented technology (non-T/S know-how)
8/14/2019 Ron Laurie
6/21
Patent Valuation
Relative Importance of Intangible assets in Company Value
S&P-500 Market to Book (M/B) Value Ratio - 1970s - 1:1; 2000 - 6:1 (83.3%)
Coopers & Lybrand (97) - 2/3 of $7 trillion market value of all public companiesis attributable to intangible assets
Examples (2000 figures): Merck - 93.5%, Microsoft - 97.8%, Yahoo - 98.9%
Intangible Assets include:
Intellectual Capital - undocumented know-how, customer loyalty,management expertise, inter-company relationships, etc.
Intellectual Property - Legally enforceable rights in patents,copyrights, trademarks, trade secrets, mask works, databases,domain names, etc.
8/14/2019 Ron Laurie
7/21
Patent Valuation
Why are IP assets more difficult to value than tangible assets?
Historically, no public trading markets (but this is changing, e.g., yet2com)
Terms & Conditions vary widely.
IP assets are inherently dissimilar
IPR transfers are often motivated by unique strategic considerations
Details of IPR transfers are usually not widely disseminated
8/14/2019 Ron Laurie
8/21
Patent Valuation
The Three Basic Valuation Methodologies
A. Cost -
Based on cost to replicate, e.g., independently develop (lessfunctional or economic obsolescence)
Advantage: Easy to calculate
Problems:
No relationship to utility or market value
Independent development is not a defense to patentinfringement
8/14/2019 Ron Laurie
9/21
Patent Valuation
The Three Basic Valuation Methodologies - cont .
B. Market -
Based on market transactions involving comparable assets(with adjustment for differences)
Requires: (a) an active market; (b) sufficient number of similar exchanges; and (c) publicly available price information
Sources: M&A Databases, SEC Disclosures,, Subscription-based services(e.g., NERAC), Trade Magazines, Industry websites, etc.
Problems: What is comparable IP? Ignores Deal Leverage
8/14/2019 Ron Laurie
10/21
Patent Valuation
The Three Basic Valuation Methodologies - cont .
C. Income -Discounted Net Cash Flow (royalties/profits/savings)
Price Premium (vis--vis comparable goods without IP)
Production Cost Savings (contribution of inputs)
Relief from Royalty (what rate?)
Residual Earnings (requires disaggregation of intangible assets)
Adjusted for technology and market risk (15-70%) and financing cost
Problem: Future uncertainty, especially. if no track record (i.e., notapplicable to new IP or strategic IP held for competitive
advantage)
8/14/2019 Ron Laurie
11/21
Patent Valuation
IP-Specific Valuation Methodologies
The Twenty Five Per Cent Rule
Industry Standards
Rating & Ranking
Surrogate Measures
Monte Carlo Analysis
Real Options
Other
8/14/2019 Ron Laurie
12/21
Patent Valuation
IP-Specific Valuation Methodologies - Cont.
The Twenty Five Per Cent Rule : Licensor should receive 25% of licenseesgross profit attributable to the licensed technology
Apportionment not valuation rule
Rule of Thumb only - Adjust percentage up or down to reflect partiesrespective investment and risk in licensed technology
Better for process than product technology - Allocation problems
Crude guideline for order of magnitude royalty rate
Opinion varies on usefulness of rule
8/14/2019 Ron Laurie
13/21
Patent Valuation
IP-Specific Valuation Methodologies - Cont.
Industry Standards -
Derived from Market approach
References royalty rates (or purchase prices) in similar past transactions
Reflects Industry, technology, degree of innovation, etc.
Typical rates:Infotech: hardware - 1-5%, software - up to 25%, games - up to 50%Consumer electronics: 1-3%, Biotech: 8-12% (w/large upfront fees),Automotive: 2-5%, Health Care: 2-10%
8/14/2019 Ron Laurie
14/21
Patent Valuation
IP-Specific Valuation Methodologies - Cont.
Rating & Ranking -
Compares relative value of IP assets on a subjective or objective scale
Often used in conjunction with Industry Standards method
Five components; (a) scoring criteria; (b) scoring system; (c) scoring scale;(d) weighting factors; and (e) decision table
15 Georgia-Pacific factors is often used set of comparative criteria
8/14/2019 Ron Laurie
15/21
Patent Valuation
Surrogate Patent Value Indicators
Patent portfolio data -
Number of patents issued to company (reflects R&D level and filingactivity, but not necessarily quality)
Payment of patent maintenance fees (does not necessarily reflecthow well patent portfolio is being managed)
Forward prior art citations (reflects importance of disclosure, notnecessarily coverage, i.e., claims scope)
Royalty income -
Studies indicate that investors value a dollar of patent royalty 2-3 times higher than a dollar of ordinary income (higher profit margin, more stable income)
8/14/2019 Ron Laurie
16/21
Patent Valuation
Monte Carlo Analysis
Refinement of Income method
Assigns a range of values to variables used in calculating NPV, e.g.,
Price variables: price premium, additional unit salesCost variables: COGS, SG&A
Assigns a probability to individual values within a range -
Probability distributions: uniform, triangular, normal, log-normal
Calculation of NPV is repeated 500-1,000 times based upon random selection of probailityweighted values assigned to each variable, multiple NPVs are then plotted by frequencyof occurrence, indicating most likely NPV
Accuracy of NPV values is no better than accuracy of value ranges and probabilitiesassigned to individual values.
8/14/2019 Ron Laurie
17/21
Patent Valuation
Real Options
Based on Black-Scholes formula for valuing stock options -
Five variables: (a) remaining development cost to commercialize IP; (b) meanmarket value of products embodying similar patents; (c) time until commercialutilization; (d) product value volatility; (e) risk-free rate of return; (f) patentexpiration
Option value resides in right to wait and see what happens to stockprice and to exercise or not based thereon
IP investment is viewed as an option to develop the IP further or to abandon itdepending on future technology and market information
RO is most useful for IP investments with long-term returns and high risks because itrecognizes that risk of IP investment is not uniform over time but decreases as additionaltechnical and market information becomes available
8/14/2019 Ron Laurie
18/21
Patent Valuation
The Black-Scholes formula for valuing stock options
c t =S t N(h) Xe-rt
N (h - )
c = call option present value
S = market price of underlying stock
X = option strike price
= time until option must be exercised
2
= variance (variability) of underlying stock price return
r = risk free rate of return (e.g., rate offered on 5 year US bonds)
h = {ln (S/X) + r + 2 /2}/
8/14/2019 Ron Laurie
19/21
Patent Valuation
Mapping the Black Scholes variables from the stock call option space to thepatent value space --
C becomes the present value of the patent(s)
S becomes the value of the underlying commercializable technology (market-driven meanenterprise value per product at launch) supplied by market data in the form of other pureplay companies with products in the same technology niche as subject patent
X becomes the remaining development cost to get to commercial product (covered by patent) supplied by patent owner
becomes the remaining development time until launch of product (covered by patent) supplied
by patent owner
2 becomes the variance of product value (ROI) vs. time
r (the risk-free rate of return) remains the same
8/14/2019 Ron Laurie
20/21
Patent Valuation
Take Away:
The best that can be said about current methods of IP valuation isthat they are better than nothing -
(but how much better is a matter of substantial disagreement).
It is a sign of an educated mind not to expect more certainty from asubject than it can possibly provide . (Aristotle)
Valuation requires an intermediate perspective between ignorance and certainty, involving the exercise of skill, experience and judgment (Razgatis)
8/14/2019 Ron Laurie
21/21
Patent Valuation
So, what about the role of claims construction? --
Present quantitative valuation methods are essentially actuarial in nature:
i.e., they deal with individual patents, and patent portfolios, on asemi-statistical basis, approximating value based on comparison
with past transactions involving similar patents, or using analogiesto other kinds of intangible rights (e.g., stock options).
In the future, economists and patent lawyers will work together to create avaluation that better reflects the exclusivity domain , i.e., the market, defined by
the patent claims.